So, guys I've been reading some of Desty's posts again. Bear with me -- trying to understand this kind of trade. So the skew is warped by the institutional take. I.e., they selling calls somewhere outside and buying puts (likely) somewhere nearer the money. So, some of these guys get the bright idea to take a vega neutral put spread and delta hedge the combo. For example, short ATM put and long outside puts (vega neutral). This structure kind of interests me. The first reason is that it's designed to let the take work for you, because the near puts are (likely) bid. On the other hand, there's a lot of shops that are likely getting a little 'thrifty' and bidding further outside and/or opportunistically to get a better deal (in relation to skew). At a higher level (maybe a little too high for me), they say with this spread, you are using theta to finance your gamma, and hoping the market doesn't crash, or at least that you can trade around any move since you are always ready to trade (long outside leg). How far off am I with this?
You're setting up a backspread. If you're Vega neutral you'll need realized vol to increase. I don't see a backspread as a vol-trade as much as spot vol realizing gamma. Backspreads work best as wing prot where you don't have the stomach to buy downside singles. On index, the "near puts" being bid are going to be trading under the vol of your 2X wings you're long, so it's always going to be -edge on the vol-line. They are hard to trade. As prot they are fine as you're net long a single as long as you treat them as a sunk cost or you're trading them on a price spec... you want to be long or short into a predicted sizable move. Call backspreads (up/out) are the revenue side so you're paying more (or receiving a smaller credit) and vol generally trades inverse to price (stocks up, vol down), so they are generally contraindicated over simply going long a single and hedging (buy 10-line upside, weak hedge) but then you've also got convergence risk (vol as synthetic time, drift, etc.) perhaps mitigated by sticky D. They are unforgiving. For someone that doesn't want to put a lot of effort in and trade passive long vol -> buy some 20D calendars or bear diagonals (in structure-> M2 stuck above M1 in puts) and short a single at 10D to approach rev-neutral. Long OTM flies (long g, all otm) with the distant wing in another duration, etc.
If you're truly going for vega-neutral, rt-neutral (hard) then you're always going to be net short a lot of contracts (if in term structure). I was thinking from the first part of your post that you were discussing long backspreads (short one 50D ATM put, long two 40D puts).
I must say well written Poops dumbed down enough that beginners to intermediate traders could follow everything you wrote. Keep it up bro
"PUT backspreads (up/out) are the revenue side so you're paying more (or receiving a smaller credit) and vol generally trades inverse to price (stocks up, vol down). The put side (down and out) are revenue side as you're net wings at -edge. I am not used to discussing backspreads into skew. It's always more costly where you need the hedge... My skew model is based upon net 1x1 verts (cs/ps, flies). Upside backspreads are cheap, expensive downside. put backs benefit from volcorr and call backs benefit from sticky D.
What do you think the best way to hedge a long portfolio against a sudden large (5% plus) downside move would be? I have been using long put backspreads @ 0 cost, 7 dte with the short positioned one strike away from the atm combo added together.
Zero outlay is cheap (wide) but you risk expiring inside the strikes. I prefer short flies, asym, as they perform like a limited risk RR.
I used to run a seminar on RV trades with this as the M2 maturity. It's 60-70% of my book. The rest being vol-arbs (that add buying power) and D1 spec.